ASSESSMENT OF THE IMPACT OF EXCHANGE RATE VOLATILITY ON INTERNATIONAL INSURANCE TRANSACTIONS IN NIGERIA (A CASE STUDY OF LEADWAY ASSURANCE COMPANY)

CHAPTER ONE

INTRODUCTION

1.1 Background to The Study

The stability of the financial sector is crucial to the growth of any economy worldwide as it determines the level of investment, the flow of money into the financial sector and the level of trade between countries. Economies cannot operate in isolation as they must relate to each other, which sometimes leads to distortions in their exchange rates. Exchange rate distortions, also known as exchange rate volatility, are unexpected fluctuations in exchange rates. It is also a measure of risk, instability, volatility or uncertainty.

 

According to Mulwa (2013), exchange rate volatility explains the uncertainty of international transactions in both financial assets and commodities. Exchange rate fluctuations can be a major source of risk faced by many institutions, particularly the insurance sector. These exchange rate fluctuations represent a setback for institutions, particularly those whose securities are traded in the money market and which also carry out foreign transactions, as this would potentially expose them to the risk of currency fluctuations. Significant losses, reduced investment returns, a decline in premium income and a decline in the profitability of the insurance industry can all be caused by adverse exchange rate volatility. Because the insurance sector moves funds from economically surplus entities to those in need of investment for economic progress, it is, like banking and financial markets, critical to the distribution of financial resources.

 

As a financial intermediary, the insurance industry provides risk management services through which funds are mobilized and made available to other economic actors for investment purposes. The insurance sector faces uncertainty caused by exchange rate volatility due to the inability to predict the exchange rate with certainty. The risk and decision to invest in the face of a volatile exchange rate can have a major impact on the performance of the insurance sector (Akinlo & Apanisile, 2014; Alhassan & Fiador, 2014; Olayungbo & Akinlo, 2016).

 

The Nigerian insurance sector, which relies heavily on foreign transactions such as reinsurance and risk-sharing arrangements, faces particular challenges due to these volatilities. The dynamics of exchange rate movements affect the cost of premiums, claims settlement and the general financial stability of insurance companies.

 

As Adeniyi et al. (2020) asserts exchange rate volatility in Nigeria has increased significantly due to macroeconomic instability, including fluctuations in crude oil prices, which directly affect foreign exchange reserves. International insurance transactions are highly vulnerable to fluctuations in exchange rates, primarily because these transactions frequently involve contracts denominated in foreign currencies. Consequently, Nigerian insurance companies are exposed to currency risk, which, if not effectively managed, can result in substantial financial losses.

 

Afolabi (2021) underscores that sudden fluctuations in exchange rates have led to increased expenses for insurance companies, especially when settling claims with foreign reinsurers. Furthermore, the naira's depreciation against major currencies, such as the US dollar, exacerbates these issues by lowering local businesses' purchasing power and complicates compliance with international contractual obligations. The challenges posed by exchange rate volatility are further aggravated by the regulatory framework and the limited availability of hedging instruments within the Nigerian market. Chukwu and Okeke (2022) point out that the Nigerian financial markets do not have a variety of currency hedging options, which limits insurance companies' capacity to properly manage the risks associated with exchange rate swings. Furthermore, the stringent regulatory requirements for foreign reinsurance placements add another layer of complexity in controlling currency risk.

 

In addition, according to Yakubu et al. (2019), the National Insurance Commission (NAICOM) imposes specific thresholds for offshore reinsurance, which inadvertently increase the exposure to exchange rate risk. Therefore, it is critical for Nigerian policymakers and insurance experts to understand the impacts of currency rate volatility. The sector's challenges could be addressed by increasing local reinsurance shares, improving the stability of the foreign exchange market and promoting the use of modern risk management systems.

 

Studies like those conducted by Eze et al. (2021) and Oluwaseun and Bello (2023) offer a foundation for tackling these problems by promoting improved financial market policy integration with the requirements of the insurance industry. Thus, the purpose of this study is to assess the precise influence of exchange rate volatility on international insurance transactions in Nigeria and offer workable ways to reduce its negative consequences.

 

1.2 Statement of The Problem

Exchange rate volatility poses a critical challenge to the operations of international insurance transactions in Nigeria, disrupting the financial stability and efficiency of the sector. Nigerian insurance companies often engage in cross-border transactions such as reinsurance, premium payments, and claim settlements, which are predominantly denominated in foreign currencies. Frequent fluctuations in the value of the naira against major currencies, such as the US dollar, have exposed these firms to significant currency risks, increasing their operational costs and diminishing profitability. For instance, as Okonkwo and Adewale (2021) observed, the persistent depreciation of the naira has heightened the financial burden on insurers, particularly in meeting their obligations to foreign reinsurers, which are essential for risk-sharing and capacity-building.

 

Additionally, the lack of effective risk management strategies and limited availability of hedging instruments in Nigeria exacerbate the challenges posed by exchange rate instability. Nigerian insurance firms are often forced to absorb the adverse impacts of currency fluctuations due to inadequate access to financial tools such as currency derivatives, which are commonly used in more developed markets to mitigate exchange rate risks. According to Musa and Adebayo (2022), this situation is further compounded by regulatory constraints that limit the ability of insurers to effectively diversify their exposure. These challenges have not only undermined the competitiveness of Nigerian insurance firms in the global market but have also hindered their capacity to contribute significantly to economic growth and financial stability within the country. This research seeks to address these pressing issues by examining the multifaceted impacts of exchange rate volatility on international insurance transactions in Nigeria.Top of Form

 

1.3 Objectives of The Study

The main objective of the study is to assess the impact of exchange rate volatility on international insurance transactions in Nigeria. Specific objectives of the study are:

1. To examine the impact of exchange rate volatility on the volume of international insurance transactions in Nigeria.
2. To assess the impact of exchange rate volatility on the profitability of international insurance transactions in Nigeria.
3. To analyze the strategies employed by international insurance companies in Nigeria to mitigate the risks associated with exchange rate volatility.

1.4 Research Questions

To guide the study and achieve the objectives of the study, the following research questions were formulated:

1.   How does exchange rate volatility influence the volume of international insurance transactions in Nigeria?
2. What is the impact of exchange rate volatility on the profitability of international insurance transactions in Nigeria?
3. What strategies are employed by international insurance companies in Nigeria to mitigate the risks associated with exchange rate volatility?

1.5 Research Hypothesis

The following research hypothesis was developed and tested for the study:

Ho: Exchange rate volatility has no significant impact on international insurance transactions in Nigeria.

1.6 Significance of The Study

The study is important for many reasons. The following are the major stakeholders this paper through its practical and theoretical implications and findings will be of great significance:

Firstly, the paper will benefit major stakeholders and policy makers in the Actuarial Science sector. The various analysis, findings and discussions outlined in this paper will serve as a guide in enabling major positive changes in the industry and sub-sectors.

Secondly, the paper is also beneficial to the organizations used for the research. Since first hand data was gotten and analyzed from the organization, they stand a chance to benefit directly from the findings of the study in respect to their various organizations. These findings will fast track growth and enable productivity in the organizations used as a case study.

Finally, the paper will serve as a guide to other researchers willing to research further into the subject matter. Through the conclusions, limitations and gaps identified in the subject matter, other student and independent researchers can have a well laid foundation to conduct further studies.

1.7 Scope of The Study

The study is delimited to Leadway Assurance Company. Findings and recommendations from the study reflects the views and opinions of respondents sampled in the area. It may not reflect the entire picture in the population.

1.8 Limitations of The Study

The major limitations of the research study are time, financial constraints and delays from respondents. The researcher had difficulties combining lectures with field work. Financial constraints in form of getting adequate funds and sponsors to print questionnaires, hold Focus group discussions and logistics was recorded. Finally, respondents were a bit reluctant in filling questionnaires and submitting them on time. This delayed the project work a bit.

1.9 Organization of The Study

The study is made up of five (5) Chapters. Chapter one of the study gives a general introduction to the subject matter, background to the problem as well as a detailed problem statement of the research. This chapter also sets the objectives of the paper in motion detailing out the significance and scope of the paper.

Chapter Two of the paper entails the review of related literature with regards to corporate governance and integrated reporting. This chapter outlines the conceptual reviews, theoretical reviews and empirical reviews of the study.

Chapter Three centers on the methodologies applied in the study. A more detailed explanation of the research design, population of the study, sample size and technique, data collection method and analysis is discussed in this chapter.

Chapter Four highlights data analysis and interpretation giving the readers a thorough room for the discussion of the practical and theoretical implications of data analyzed in the study.

Chapter Five outlines the findings, conclusions and recommendations of the study. Based on objectives set out, the researcher concludes the paper by answering all research questions set out in the study.

1.10 Definition of Terms

1. Exchange Rate Volatility

This refers to the fluctuations or variations in the value of a country's currency relative to foreign currencies over a given period. In the context of Nigeria, it specifically addresses the rate at which the Nigerian Naira (NGN) fluctuates against international currencies, such as the US Dollar (USD) or Euro (EUR).

1. International Insurance Transactions

 These are insurance-related activities that involve cross-border dealings, where the parties engaged in the insurance contract are located in different countries. This includes the payment of premiums, claims, and underwriting processes involving foreign insurers, reinsurers, and policyholders.

1. Currency Risk

 Also known as exchange rate risk, it refers to the potential for financial losses arising from unfavorable movements in exchange rates. For Nigerian international insurance transactions, this risk manifests when insurance premiums or claims are denominated in foreign currencies, exposing Nigerian insurers and policyholders to fluctuations in exchange rates.

1. Hedging Strategies

These are financial techniques or tools used to manage and mitigate the risks associated with exchange rate volatility. In the insurance industry, hedging strategies might include the use of forward contracts, options, or swaps to lock in exchange rates and minimize the impact of currency fluctuations on insurance transactions.

1. Premium Adjustment Mechanism

This refers to the method by which insurance companies adjust the premiums they charge based on changes in exchange rates. For international transactions, if the value of the Nigerian Naira weakens relative to foreign currencies, insurers may adjust premiums to account for the increased cost of settling claims in foreign currencies.

1. Reinsurance

 Reinsurance is the practice where an insurance company (ceding company) purchases insurance from another insurance company (reinsurer) to limit its risk exposure. Exchange rate volatility can affect the cost of reinsurance for Nigerian insurers who engage with foreign reinsurers, particularly if premiums or claims are paid in foreign currencies.

1. Risk Exposure

This refers to the degree to which an individual, organization, or company is vulnerable to the effects of exchange rate fluctuations in international transactions. For Nigerian insurance companies, risk exposure in international transactions can arise from foreign-denominated policies, investments, or claims settlements that are impacted by exchange rate changes.

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